I wrote the following article for the Hamilton Law Association Journal on Ehresman v R, 2025 TCC 78. For another summary of the case, see Colin Bartlett “Are Excess Cash Reserves an Active Business Asset?” 25:4 Tax for the Owner-Manager (October, 2025).
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Under the Income Tax Act (Canada) (the “Act”),[1] capital gains realized on “qualified small business corporation shares” (“QSBCSs”) can be sheltered by the lifetime capital gain exemption. A taxpayer’s shares will be QSBCSs as defined in the Act if
(1) the taxpayer has held the shares for two years before the date of the disposition;
(2) throughout that two-year period, more than 50% of the gross fair market value of the assets of the issuer of the shares was attributable to assets used principally in an active business carried on primarily in Canada;[2] and
(3) at the time of the disposition, more than 90% of the gross fair market value of the issuer’s assets was attributable to assets used principally in an active business carried on primarily in Canada.
The foregoing is a rough summary of some complicated rules, but it captures the importance of the use made of the assets of the issuer of the shares.
Cash, to be a “good asset” for the tests in (2) and (3) above, must be used in an active business of the issuer. The CRA takes a narrow view of what cash is used in a business, and in general, the courts have upheld the CRA’s view. Ehresman v R[3] provides yet another example. Mr and Mrs Ehresman had claimed the capital gain exemption for a gain each of them had realized in 2014 on the sale of shares of a corporation (“Opco”). The CRA reassessed to deny their claims. The Tax Court upheld the reassessments.
Opco owned a number of oil wells and a financial advisory services business. The Court accepted that both the oil well and financial advisory activities were active businesses. Before the taxpayers sold their Opco shares, they had undertaken a reorganization to remove all of the assets from Opco other than the goodwill of the financial advisory business. Opco’s businesses had been successful, and so a large amount of cash had to be removed. It appears the pre-sale reorganization ensured the 90% test in (3) above was met. The CRA, however, took the view that Opco, at some point in the two years leading up to the sale, had had too much cash to satisfy the 50% test in (2) above.
The Court found that, to meet the 50% test, the taxpayers needed to show $710,000 of the cash held by Opco — the “magic number” — was used by the corporation in its active businesses.[4]
The taxpayers argued the magic number was met because $750,000 of cash was used in Opco’s oil well business: the money was needed as a reserve for decommissioning the wells.[5] The Tax Court judge did not accept the taxpayers’ arguments.
The Court referred to the relevant case law regarding whether cash is used in a business, including especially Ensite Ltd. v R.[6] The Court summarized the test to be met as follows:
The cases focus on whether, as a factual matter, the financial assets are so integral to the active business to which they purportedly relate that they are at risk in that business and cannot be removed from the business without destabilizing the business [emphasis added]. Where the assets are asserted to be needed as a kind of insurance to meet future risks or expenses, the courts look at how real the risk is and how reasonable the amounts of the financial assets are having regard to what resources are actually required to deal with the risk in issue.[7]
The Court found that the foregoing test was not met:
Sooner or later, [Opco] would have had to decommission its wells and incur the related costs, but the evidence falls well short of showing that any amount was required in the two years leading up to 2014, still less does it support setting aside the $710,000 needed to cross the 50% threshold in issue. Worse still, there is little evidence that the appellants turned their minds to setting aside reserves or that they thought about what a reasonable reserve would be. I find that the appellants did what the taxpayers in the other decided cases did. Mr. and Mrs. Ehresman’s company earned money and kept the retained earnings in the business, reinvesting the income from the retained earnings for no particular reason and certainly not to meet a future risk of a likely modest magnitude.[8]
The Court lamented the absence of expert evidence concerning the costs of decommissioning Opco’s oil wells. Mr Ehresman testified, as did an employee of the Saskatchewan government. The Court accepted that both witnesses were experts of a sort on the oil and gas business, but neither of them testified about the actual condition of Opco’s wells or the likely costs of decommissioning them. Instead, both witnesses provided general information about the range of decommissioning costs that might be incurred, which ranged from the relatively modest to the catastrophic.
Regarding Mr Ehresman’s testimony, the Court found that he did not have specific and developed ideas about the costs of decommissioning the wells. The Court noted the following:[9]
- Opco’s statements — which appear to have been “notice to reader” statements — contained no provision for the costs. The Court wrote “Preparing uninformative financial statements on the basis that only the CRA will see them is not a great look in the Tax Court”.
- Opco’s accountant had provided the CRA with a list of its liabilities that included decommissioning costs of $100,000. The Court treated the list as an admission and as evidence “that Mr. Ehresman did not, in 2014, believe that the decommissioning costs would be extraordinarily high.”
- Opco’s statements did not allocate any retained earnings to the oil and gas business as such.
- Opco had no written plan for addressing the decommissioning costs, and it did not operate or “organize its financials” in a manner that took those costs into account.
- Mr Ehresman never told the CRA about the costs, which suggested to the Court that the “costs” became a concern only after the CRA put the 50% test in issue.
The Court concluded its review of the evidence regarding the decommissioning costs as follows:
[68] There is therefore no admissible evidence from anyone as to the actual cost of decommissioning the Original Wells. The only opinion evidence that existed in 2014 is that there is a range of cost for decommissioning wells in general. Both Messrs. Ehresman and Wagner [the Saskatchewan government employee] essentially held an opinion about a liability range that ran from low to infinity with lower being more probable and very high being less likely.
[69] To allow the theoretical possibility of huge decommissioning cost overruns to determine this appeal goes completely against the developed case law. Not every possible risk can ground adding investment assets to an active business, lest the net be cast so wide that it gathers in all before it. As Ensite states, “‘risked’ means more than a remote risk”. Only investments that are pre-conditions to carrying on business or amounts, the withdrawal of which would destabilize the business, meet the test in the case law.
The Court stated that it might have been convinced by a higher amount for the reserve if Mr Ehresman had turned his mind to the issue, if the reserve amount had taken into account the wells actually owned by Opco and if the estimate of the amount of the reserve had taken into account when the costs were likely to be incurred.[10] In the absence of any such evidence, the Court felt compelled to dismiss the taxpayers’ appeals and confirm the CRA reassessments.
[1] All statutory references are to the Act unless otherwise noted.
[2] See subparagraph 110.6(1) “qualified small business corporation share” (c)(i).
[3] 2025 TCC 78 (“Ehresman”).
[4] Ehresman, at ¶19.
[5] Mr Ehresman apparently also mentioned that Opco might need the excess cash to make other investments, presumably in active businesses (¶20). The Court dismissed this argument out of hand (¶74).
[6] 1986 CanLII 41 (SCC), [1986] 2 SCR 509. See especially the quote from Ensite at ¶28 of the Tax Court judgment.
[7] Ehresman, at ¶27.
[8] Ehresman, at ¶34.
[9] Ehresman, ¶¶50ff.
[10] Ehresman, at ¶70.
